What is the Bright-line test and is your property sale exempt

What is the Bright-line test and is your property sale exempt

What is the Bright-line test?

The Bright-line test or “Bright-line rule” (the rule) determines whether income tax is payable on the profit of the sale of a residential property, based on the period of time it has been owned. If the rule applies, income tax will be payable on the net profit, calculated at the owner’s personal marginal tax rate, unless an exclusion applies.

When does the Bright-line rule apply?

The bright-line rule applies to all residential property acquired:

  • Between 1 October 2015 and 28 March 2018, and sold within the 2-year bright-line period;
  • Between 29 March 2018 and 26 March 2021, and sold within the 5-year bright-line period; and
  • On or after 27 March 2021, and sold within the 10-year bright-line period.

Other property sale rules may still apply

It is important to know that even if you sell a property outside of the applicable period and the bright-line rule does not apply, there are other property sales tax rules that may apply when:

  • You bought the property and had a firm intention to sell it;
  • You have a regular pattern of buying and selling, or building and selling, your main home; or
  • A person you’re associated with is in the business of property dealing, developing or building, and the property was bought for the business.

What are the exclusions to the Bright-line rule?

Main home exemption

Your main home is excluded from the bright-line rule. This exclusion can only be used with respect to one property. Further, if you sell your main home twice or more within a two-year period, you will not be able to claim this exception.

If a residential property was acquired on or after 29 March 2018, and before 27 March 2021, the main home exemption is assessed based on whether the property has been used as a main home for over half of the relevant bright-line period. If it has, a sale of the property will not be taxable under the bright-line test. 

Under this assessment, the main home is either “fully in” or “fully out” of the main home exclusion. For example, for property acquired before 27 March 2021, a person can qualify for the main home exclusion where the property is rented out for some of the time it is owned, provided it is used as the owner’s main home for more than 50 percent of the bright-line period.

Change of Use rule

The 2021 amendment means the main home exemption for properties acquired on or after 27 March 2021 will be subject to a “change of use” rule.

If a property switches from being the owner’s main home for more than 12 months, then a proportion of the sale profits will be subject to tax. This proportion is based on the ratio of time that the property was and wasn’t used as the main home. The time that the property was not used as the main home is taxable. Changes of use lasting less than 12 months are ignored provided that the period is immediately before or after a period where the property was the main home.  

A main home held in trust

Residential properties held in trust may use the main home exclusion if the property was the main home of a beneficiary of the trust, and:

  • the principal settlor does not have a main home; or
  • it is the main home of the principal settlor of the trust that is being sold. 

However, people cannot use the main home exclusion for multiple properties held through trusts.

What if I purchase a section to build my home on?

The main home exemption doesn’t apply to bare land. If you purchase a section with the intention of building but circumstances change and you sell the section before completing the build, you will not be able to claim the main home exemption.

What about inherited property?

Inherited property does not come under the rule. However, if any part of the property is acquired other than by inheritance, it may be subject to the bright-line rule when it is sold.

How does it apply to relationship property?

In most circumstances, property that is subject to a relationship property settlement and/or agreement will not be subject to the rule, however, if the property is subsequently sold, the bright-line rule may apply. This depends on the date the incoming partner originally acquired an interest in the property, as this triggers the time frame for assessing whether the applicable 2, 5 or 10 year bright-line period applies to the sale.

Short-stay accommodation

Only residential land is subject to the bright-line rule, so there is a carve out for business premises and farmland.

Changes to the Income Tax Act 2007 under the recent 2021 amendment have now extended “residential land” to include residential properties which provide short-stay accommodation such as Air BnB’s. These properties are now subject to the bright-line test, however, there are exclusions for bed and breakfast type facilities which are also the owner’s main home that they live in.

What about “New Builds”?

The government has indicated that new builds will continue to be subject to a 5 year bright-line period however ‘new build’ remains undefined. It appears that the legislation will be retrospective so new builds acquired on or after 27 March 2021 will continue to be subject to a 5-year bright line period however this is not yet certain.  

A word about Residential Land Withholding Tax (RLWT)

If you’re an “Offshore Person” (as defined in the Income Tax Act, but generally, this is a vendor who is living or established outside of New Zealand) and sell a property subject to the bright-line rule, your solicitor (or conveyancer) is required to deduct a withholding tax at the time of the sale, unless a valid exemption certificate is held. There is no automatic main home exclusion for offshore persons.

This rule can sometimes catch people by surprise where a property is held by a Trust where there are offshore trustees and/or beneficiaries, or a company that has overseas shareholders.

Disclaimer: This material is general in nature and has been provided for informational purposes only and is not intended to be relied upon as advice. You should seek appropriate advice based on your individual circumstances. The proposals are subject to consultation and there could be changes prior to introduction into law.

One of our Property Team would be more than happy to talk to you and discuss your situation and how the bright-line rule may affect you.